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Corporate governance & business ethics

UNIT-I

Meaning of corporate governance


Corporate governance involves a set of relationships between a companys management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined

Corporate governance is: 1. a relationship among stakeholders used to determine and control the strategic direction and performance of organisations. 2. Concerned with identifying ways to ensure that strategic decisions are made effectively. 3. Used in corporations to establish order between firms owners and its top level managers.

Some Definitions Of Corporate Governance

corporate governance refers to the processes and structure by which the business and affairs of the company are directed and managed, in order to enhance long-term shareholder value through enhancing corporate performance and accountability, whilst taking into account the interests of other stakeholders. -CGC Report

An Indian Definition
fundamental objective of corporate governance is the enhancement of the longterm shareholder value while at the same time protecting the interests of other stakeholders.
SEBI (Kumar Mangalam Birla) Report on Corporate Governance, January, 2000

Corporate governance involves a set of relationships


between a companys management, its board, its shareholders and other stakeholders ..also the structure through which objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.
Preamble to the OECD Principles of Corporate Governance, 2004

Corporate governance is the process whereby people in power direct, monitor and lead corporations and thereby create ,destroy the structures and systems under which they operate. Corporate governors are both potential agents for change and also guardians of existing ways of working. As such they are therefore, a significant part of the fabric of our society. Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. - The journal of Finance.

NATURE OF CORPORATE GOVERNANCE


The term corporate governance, although commonly used, has no standard definition. It encompasses a wide range of items and activities, and holds different meanings for different user groups. In the CGC Report, corporate governance refers to the processes and structure by which the business and affairs of the company are directed and managed, in order to enhance long-term shareholder value through enhancing corporate performance and accountability, whilst taking into account the interests of other stakeholders

A historical perspective of corporate governance


From a narrow to a broader version: CG traditionally focussed on the problem of separation of ownership by shareholders & control by mgmt.But with passage of time it is now accepted that firms should respond to the expectations of more categories of stakeholders that include-

Board of Directors, management, owners Business partners Current and retired employees, and their families Suppliers Lenders Customers Government Communities where business operates and sells

The growth of modern ideas of CG from the USA: The seeds of CG were sown by the Watergate scandal during the Nixon presidency in the U.S. Legislation of Foreign & corrupt practices Act of 1977 in America that reviews the internal control in an establishment. In the same year (SEC) proposed mandatory reporting on internal financial controls. In 1985 a series of high profile business failures rocked the US which led the government to appoint the Treadway Commission. It highlighted the need for proper control mechanisms, independent audit committees & an objective Internal Audit system.

England catches up: Famous corporations in the UK collapsed due to poor mgmt & lack of control. The Cadbury committee: Realizing the inefficacy of existing legislation & selfregulation a committee under the chairmanship of Sir Adrian Cadbury was appointed by the London Stock Exchange in 1991. It was assigned the task of drafting a code of practices to assist corporations in England for limiting their exposure to financial loss.

The aftermath of the Cadbury Report: The committee submitted its report along with code of best practices in December 1992. The most controversial of the Cadburys recommendations was that the directors should report on the effectiveness of a companys system of internal control After 5 years of publication of the report peoples confidence was again shaken by scandals. To deal with the situation a committee on CG headed by Ron Hampel was constituted to assess the Cadbury report & develop further guidelines.

The final report of the Hampel committee in 1998 contained extension of directors responsibilities to all control objectives including risk assessment & minimising the risk of fraud. A amalgam of these codes known as the combined code was subsequently derived. It is appended in the listing rules of London Stock Exchange. Scandals such as Enron, Tyco, and WorldCom shook investor confidence in financial statements and required an overhaul of regulatory standards. An act was passed by U.S. Congress in 2002,the Sarbanes-Oxley Act (SOX) in response to the accounting scandals in the early 2000s.

Need for corporate governance


Separation of ownership from management. Global capital. Investor protection Foreign investments Financial reporting and accountability Banks and financial institutions Globalisation of economy

Importance of corporate governance


It shapes the growth and future of capital market in the economy. It helps in raising funds from capital markets. It links management with its financial reporting system It helps management to take rational decisions within the legal framework of accountability. It makes corporate accounting practices transparent. It avoids insider- trading It is an instrument of economic growth It improves international image and helps to raise global funds.

Principles of corporate Governance


Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings. Interests of other stakeholders: Organizations should recognize that they have legal, contractual, social, and market driven obligations to non-shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers.

Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Cont
Accountability Independence Reporting of yearly performance and operating results

Characteristics of corporate governance


Discipline
All involved parties will have a commitment to adhere to procedures, processes, and authority structures established by the organization. All actions implemented and their decision support will be available for inspection by authorized organization and provider parties.

Transparency

Independence
All processes, decision-making, and mechanisms used will be established so as to minimize or avoid potential conflicts of interest.

Accountability

Identifiable groups within the organization - e.g., governance boards who take actions or make decisions - are authorized and accountable for their actions.

Responsibility
Each contracted party is required to act responsibly to the organization and its stakeholders.

Fairness
All decisions taken, processes used, and their implementation will not be allowed to create unfair advantage to any one particular party.

Social responsibility
A well-managed company will be aware of, and respond to, social issues, placing a high priority on ethical standards

Corporate governance and organisational success


The following measures help in ensuring success of an organisation: 1. Maintain good relations with the stakeholders: stakeholders can provide gidelines to directors regarding companys strategic plans and policies. For this they have to know companies operations in complete transparency. 2. Motivate the employees: a committed workforce is motivated to work for the cause of the organisation.Following components promote a dedicated workforcevision mission goals objectives

3. Develop plans to achieve the objectives: plans are made to achieve the vision, mission, goals and objectives of the organisation. Planners must conduct a thorough market research before framing plans. 4. Define the authority and responsibility of managers: the authority and responsibility of managers should be well defined to avoid overlapping of tasks.

Factor influencing the corporate governance


1. The ownership structure 2. The structure of company boards 3. The financial structure 4. The institutional environment
problems of corporate governance

Demand for information Monitoring costs Supply of accounting information

We lay structures over the corporate business, and fail to organize the business Corporate Performance Management reports against overlaid structures Accounting accounts for only part of the business cycle and against the wrong entities We govern the corporation by rules and regulations, because we cannot manage the actual business

Corporate Governance & Capital Market Drivers: A Conceptual Framework


REGULATION & LEGISLATION

Regulators (SEBI/RBI)
Lenders (Banks/ Depositors)

Government Legislation

Stock Exchanges Listing Agreements

Listed Corporations (The Board & the Executive)

Shareholders/ Stakeholders

Market Operators (Rewards)

Institutional Investors (Pension Funds/Insce Cos)

Press/Media (Opinion Makers)

Market Operations, Critique & Monitoring

An Enterprises Triple Effect on Society


Sustainable Development Waste Control Equal Opportunities Education & Culture Community Business Impact

Emissions Regeneration Energy Use Product Life-cycle Product Value Wealth Generation Productive Employment Ethical Trading

Economic

Human Rights Employee Volunteers

The Triple-Bottom line Impact

Economics

Business Impact Environment Society

Code of corporate practices

Code of practice: ( given by Cadbury report)


The CEO and chairperson of the board of Directors should be separate. CEO is responsible for day to day operations of the company and chairman should manage the affairs of the board. The chairman should set the goals of the CEO and monitor his performance. The organisation should have non- executive Directors. They should not prove to be mere rubber stamp to enforce board decisions.

Combined code of practice:(Ron Hampel committees and Cadbury report)


It was added to the listing rules of LSE and its compliance was mandatory for all listed companies in UK. The combined code are as follows: Fool-proof system of internal control. Directors hold fiduciary relationship with the stakeholders. Directors should annually review the internal control system of the firm like financial control, operational control, compliance control and risk management. The review should be disclosed to the shareholders. It is the duty of the directors to protect investors money by not indulging in insider trading, over- invoicing, underinvoicing.

SEBI code on corporate governance


The SEBI board considered the recommendations of the Birla committee and made amendments by incorporating a new clause, namely clause 49 in the listing as under:

A. Board of directors:
Optimum combination of executive and non-executive directors, with 50% of non-executive directors.( 1/3- non-ex director), (1/2- ex. chairman)

B. Audit committee:
powers Functions Composition Frequency of meetings and quorum

Composition of the committee


The audit committee should have minimum three members, all being non executive directors, with the majority being independent, and with at least one director having financial and accounting knowledge. the chairman of the committee should be an independent director. the chairman should be present at Annual General Meeting to answer shareholder queries; the audit committee should invite such of the executives, as it considers appropriate (and particularly the head of the finance function) to be present at the meetings of the Committee but on occasions it may also meet without the presence of any executives of the company. Finance director and head of internal audit and when required, a representative of the external auditor should be present as invitees for the meetings of the audit committee; the Company Secretary should act as the secretary to the committee.

Frequency of meetings and quorum


The audit committee should meet at least thrice a year. One meeting must be held before finalisation of annual accounts and one necessarily every six months. The quorum should be either two members or one-third of the members of the audit committee, whichever is higher and there should be a minimum of two independent directors.

Powers of the audit committee


To investigate any activity within its terms of reference. To seek information from any employee. To obtain outside legal or other professional advice. To secure attendance of outsiders with relevant expertise, if it considers necessary.

Functions of the Audit Committee


Oversight of the companys financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible.

Recommending the appointment and removal of external auditor, fixation of audit fee and also approval for payment for any other services. Reviewing with the management, external and internal auditors, the adequacy of internal control systems. Reviewing the adequacy of internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure, coverage and frequency of internal audit. Discussion with internal auditors of any significant findings and follow-up thereon.

Reviewing with management the annual financial statements before submission to the board, focussing primarily on: Any changes in accounting policies and practices. Major accounting entries based on exercise of judgement by management. Qualifications in draft audit report. Significant adjustments arising out of audit. The going concern assumption. Compliance with accounting standards Compliance with stock exchange and legal requirements concerning financial statements. Any related party transactions i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives etc. that may have potential conflict with the interests of company at large.

Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. Discussion with external auditors before the audit commences, of the nature and scope of audit. Also postaudit discussion to ascertain any area of concern. Reviewing the companys financial and risk management policies. Looking into the reasons for substantial defaults in the payments to the depositors, debenture holders, share holders (in case of non-payment of declared dividends) and Creditors.

C. Remuneration of directors
The board should set up a remuneration committee to determine specific remuneration packages for executive directors including pension rights and any compensation payment.
The Committee however recognised that the remuneration package should be good enough to attract, retain and motivate the executive directors of the quality required, but not more than necessary.

Composition, Quorum etc. of the Remuneration Committee

The Committee recommends that to avoid conflicts of interest, the remuneration committee, which would determine the remuneration packages of the executive directors should comprise of at least three directors, all of whom should be non-executive directors, the chairman of committee being an independent director.

The Committee deliberated on the quorum for the meeting and was of the view that remuneration is mostly fixed annually or after specified periods. It would not be necessary for the committee to meet very often. The Committee was of the view that it should not be difficult to arrange for a date to suit the convenience of all the members of the committee. The Committee therefore recommends that all the members of the remuneration committee should be present at the meeting.

The Committee recommends that the board of directors should decide the remuneration of non-executive directors.

Disclosures of Remuneration Package

All elements of remuneration package of all the directors i.e. salary, benefits, bonuses, stock options, pension etc.

Details of fixed component and performance linked incentives, along with the performance criteria. Service contracts, notice period, severance fees.

Stock option details, if any and whether issued at a discount as well as the period over which accrued and over which exercisable.

D. Board Procedures
The board meetings should be held at least four times in a year, with a maximum time gap of four months between any two meetings. The Committee further recommends that to ensure that the members of the board give due importance and commitment to the meetings of the board and its committees, there should be a ceiling on the maximum number of committees across all companies in which a director could be a member or act as Chairman. The Committee recommends that a director should not be a member in more than 10 committees or act as Chairman of more than five committees across all companies in which he is a director. Furthermore it should be a mandatory annual requirement for every director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place.

E. Functions of the Management


1. Management discussion and Analysis report should form part of the annual report to the shareholders. it should include discussion on the following matters :

Industry structure and developments. Opportunities and Threats Segment-wise or product-wise performance. Outlook. Risks and concerns Internal control systems and their adequacy. Discussion on financial performance with respect to operational performance. Material developments in Human Resources /Industrial Relations front, including number of people employed.

2. Good corporate governance casts an obligation on the


management in respect of disclosures. The Committee therefore recommends that disclosures must be made by the management to the board relating to all material financial and commercial transactions, where they have personal interest, that may have a potential conflict with the interest of the company at large (for e.g. dealing in company shares, commercial dealings with bodies, which have shareholding of management and their relatives etc.)

F. Shareholders
1. The Committee recommends that in case of the
appointment of a new director or re-appointment of a director the shareholders must be provided with the following information: A brief resume of the director; Nature of his expertise in specific functional areas; and Names of companies in which the person also holds the directorship and the membership of Committees of the board.

2. The Committee recommends that information like quarterly results, presentation made by companies to analysts may be put on companys web-site or may be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own web-site.
3. The Committee further recommends that to expedite the process of share transfers the board of the company should delegate the power of share transfer to an officer, or a committee or to the registrar and share transfer agents. The delegated authority should attend to share transfer formalities at least once in a fortnight.

4.

The Committee recommends that a board committee under the chairmanship of a non-executive director should be formed to specifically look into the redressing of shareholder complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc. The Committee believes that the formation of such a committee will help focus the attention of the company on shareholders grievances and sensitise the management to redressal of their grievances.

G. Report on corporate governance


The Committee recommends that there should be a separate section on Corporate Governance in the annual reports of companies, with a detailed compliance report on Corporate Governance. Non-compliance of any mandatory recommendation with reasons thereof and the extent to which the non-mandatory recommendations have been adopted should be specifically highlighted. This will enable the shareholders and the securities market to assess for themselves the standards of corporate governance followed by a company. A suggested list of items to be included in the compliance report is enclosed.

H. Compliance
The Committee also recommends that the company should arrange to obtain a certificate from the auditors of the company regarding compliance of mandatory recommendations and annexe the certificate with the directors report, which is sent annually to all the shareholders of the company. The same certificate should also be sent to the stock exchanges along with the annual returns filed by the company.

I. Schedule of implementation
By all entities seeking listing for the first time, at the time of listing. By March 31, 2001 by all entities, which are included either in Group A of the BSE or in S&P CNX Nifty index as on January 1, 2000. By March 31, 2002 by all the entities which are presently listed, with paid up share capital of Rs. 10 crore and above, or networth of Rs 25 crore or more any time in the history of the company. By March 31, 2003 by all the entities which are presently listed, with paid up share capital of Rs 3 crore and above.

Features of CII code:


Well functioning, informed board of directors with a core group of professionally acclaimed non-executive directors who understand their role. The board should meet a minimum 6 times a year. No single person should hold directorship of more than 20 listed companies. Any listed company with a turnover of 100 crore and above should have competent, independent, nonexecutive directors, who should constitute: i) 30% of the board if the chairman is non-executive director Ii) 50% if the chairman and managing director is same.

For non-executive directors to play material role, they need to: i) be active participants Ii) have clearly defined responsibilities. Iii) knowledge about finance,company laws. Pay a commission over and above sitting fees for the use of professional inputs.

While re-appointing members of the board, give the attendance record of the directories. Set up audit committees within 2 years with atleast 3 members from non-executive directors. Major stock exchanges should insist on Compliance certificate signed by CFO & CEO, stating that the mgmt will disclose proper financial information and the accounting policies and principles conform to standard practice. .

Government must allow greater funding to the corporate sector. Companies with paid-up capital of 20 crore or more, the quality and quantity of disclosure for domestic issues should be the same as that for GDR issues. Under additional shareholders information listed companies should give data on high and low monthly averages of share prices in a major stock exchange. It is the prerogative of FIs to have nominee directors in case of debt default and in case of the debtor company not providing operational data to the concerned FIs. Rating of the agency that rated the company. Companies that default on fixed deposits should not accept further deposits or declare dividends until the default is made good.

History of Corporate Governance in India


Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse Also, unlike most OECD countries, the initiative in India was initially driven by an industry association, the Confederation of Indian Industry In December 1995, CII set up a task force to design a voluntary code of corporate governance The final draft of this code was widely circulated in 1997 In April 1998, the code was released. It was called Desirable Corporate Governance: A Code Between 1998 and 2000, over 25 leading companies voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddys Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others

Cont. Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees In 2001-02, certain accounting standards were modified to further improve financial disclosures. These were: Disclosure of related party transactions Disclosure of segment income: revenues, profits and capital employed Deferred tax liabilities or assets Consolidation of accounts Initiatives are being taken to (i) account for ESOPs, (ii) further increase disclosures, and (iii) put in place systems that can further strengthen auditors independence

Cont. Following CIIs initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies The Birla Committee Report was approved by SEBI in December 2000 Became mandatory for listed companies through the listing agreement, and implemented according to a rollout plan

Driving Forces of CG in India


1) Unethical Business Practices Security Scams ---Harshad Mehtha Security Scam Equity allotments at discount rates to the controlling groups Disappearance of Companies (1993-94) - around 4,000 companies with 25,000 crores without starting business Misdeed of Companies Plantation, Sheep rearing, etc.

2) Impact of

Globalization Integration with Foreign Market Foreign Investors expectations New Business Opportunities --- IT & ITES, BPO etc., New Capital formation FII, FDI

3) Impact of Privatisation New structure of ownership Multinational Companies

BOARD OF DIRECTORS- ROLES & RESPONSIBILIIES

Roles: Establish vision, mission and values Set strategy an structure Delegate to management exercise accountability to shareholders & be responsible to other stakeholders Responsibilities: To ensure that proper books of accounts are kept.

In some cases directors may be required to pay company debts. The directors must exercise their powers for a proper purpose for which they are there. They must act in good faith for the best interest of the company. Must act with due skill and care. Must consider the interest of employees of the company.

Powers of BOD

The roles of Chairman and Chief Executive- Chairman


Ensure effective operation of the Board and its committees in conformity with the highest standards of corporate governance. Ensure effective communication with shareholders, host governments and other relevant constituencies and that the views of these groups are understood by the Board. Chair the Nominations Committee and build an effective and complementary Board, initiating change and planning succession on Board and Group Executive appointments.

Set the agenda, style and tone of Board discussions to promote constructive debate and effective decision-making.
Ensure that all Board committees are properly established, composed and operated. Ensure comprehensive induction programmes for new directors and updates for all directors as and when necessary. Support the Chief Executive in the development of strategy and, more broadly, to support and advise the Chief Executive. Maintain access to senior management as is necessary and useful, but not intrude on the Chief Executive's responsibilities.

Promote effective relationships and communications between non-executive directors and members of the Group Executive Committee. Ensure that the performance of the Board, its main committees and individual directors is formally evaluated on an annual basis. Establish a harmonious and open relationship with the Chief Executive.

Chief Executive
Develop strategy proposals for recommendation to the Board and ensure that agreed strategies are reflected in the business. Develop annual plans, consistent with agreed strategies, for presentation to the Board for support. Plan human resourcing to ensure that the Company has the capabilities and resources required to achieve its plans. Develop an organisational structure and establish processes and systems to ensure the efficient organisation of resources. Be responsible to the Board for the performance of the business consistent with agreed plans, strategies and policies.

Lead the executive team, including the development of performance contracts and appraisals. Ensure that financial results, business strategies and, where appropriate, targets and milestones are communicated to the investment community. Develop and promote effective communication with shareholders and other relevant constituencies. Ensure that business performance is consistent with the Business Principles. Ensure that robust management succession and management development plans are in place and presented to the Board from time to time. Develop processes and structures to ensure that capital investment proposals are reviewed thoroughly, that associated risks are identified and appropriate steps taken to manage the risks.

Develop and maintain an effective framework of internal controls over risk in relation to all business activities including the Group's trading activities. Ensure that the flow of information to the Board is accurate, timely and clear. Establish a close relationship of trust with the Chairman, reporting key developments to him in a timely manner and seeking advice and support as appropriate. The Chairman and Chief Executive will meet regularly to review issues, opportunities and problems.

UNIT-II

Corporate disclosure practices and investor protection


Meaning of disclosureDisclosure is a process through which business enterprises communicate and report accounting and non- accounting information to various direct and indirect users for the purpose of their analysis and decision making. Disclosure should be full, fair and adequate. Full- refers to complete and comprehensive presentation of information of financial activities in the financial reports. Fair-implies that information should be unbiased and impartial. Adequate-implies that all material information needed by the users should be included in financial statements.

Factors affecting disclosure


Divorce between ownership and management. Growing complexities of corporations. Growing awareness of public. Changing socio-political environment in the country. Greater emphasis on rational decision-making. Helps in assessing risk. Scope for improvement in internal conduct of the company.

Objectives of disclosure
Timely, consistent and appropriate disclosure of information. To protect and prevent disclosure of material information and company information. To give material information according to legal and regulatory requirements.

Why is investor protection needed?


Investor protection is associated with effective corporate governance. If there is no investor protection the insiders can easily steal the firms profits. If the investors rights are effectively enforced, it would enforce insiders to repay and distribute profits to shareholders and thereby protect external financing mechanism from breaking down.

Organisational framework for investor protection